Increased emission taxes and lower income tax can work!

The Finnish Innovation Fund called Sitra has written an excellent and profound paper on how to fight climate change with a larger environmental tax reform.

This paper is a useful road map for handling climate change, because its is already really clear that voluntary payments, as suggested by the likes of Antero Vartia (see this recent article) will not go anywhere far enough to halt harmful emissions. There must be new laws and tax reforms to change industrial and consumer habits. There is no “Planet B” to where we can all escape.

Sitra’s paper makes the point that current research shows that:

Carbon taxes are effective at reducing emissions, and

The best way to introduce them is via a budget-neutral Environmental Tax Reform (ETR) where increased emission based taxes are set off by lower income/employment taxes .

Sitra uses research that has been extensively reported in papers from the World Bank, the OECD, the IPCC, etc…

Based on the results of the 2018 IPCC Special Report, all countries and sectors should speed up emission reductions to limit global warming to 1.5 degrees. Now Sitra reports that a budget neutral situation can be achieved by lowering other taxes, such as income tax, that set off increases in emission and other environmental taxes.

Finland has historically implemented a few ETRs but not on a large scale. In their paper, Sitra analyses the potential tax instruments that could be used in Finland to support emission cuts for 3 different scenarios together with their impacts on the economy and on emissions:

The first scenario includes environmental taxes that mainly target firms and that might harm the cost-competitiveness of energy-intensive Finnish industries without compensations.

The second scenario includes environmental taxes mainly targeting consumers.

The third ETR scenario aims to promote circular economy solutions.

Their analysis and summarises the impacts of the 3 budget-neutral environmental tax reforms with two dynamic general equilibrium models. Sitra concentrates on the potential impacts on employment, GDP, emission projections and the competitiveness of different industries.

As you can see from the above picture based on their findings, all three scenarios would bring about the “double dividend” effect by significantly reducing emissions and increasing employment and GDP compared to baselines. The packages are found to be progressive and have no adverse impact on income inequality.

In addition, the export competitiveness of the Finnish economy would not be harmed by the emission tax increases if they are levied as part of a larger ETR. Based on their findings, a decrease in income taxes is key to obtaining the double dividend effect in the Finnish context.

On the other hand, Sitra noted that total employment and GDP would fall to a lower level compared to the baseline if compensation is made just by lowering corporate taxes and employers’ social security payments.

Your correspondent has heard that objections to this conclusions of this report have ben raised by a number of big Finnish companies that currently depend on fossil fuels. However, they have not raised their objections into the public domain for fear of a consumer backlash. A number of these companies are large are recipients of large public grants an tax benefits…